Bidding on Notes: How to Buy Right for YOUR Business Model

“How much” to bid on notes is probably one of the most commonly asked questions, especially coming from newer note investors.

There are three main questions, in reference to buying nonperforming notes, which really come to mind:

1.) How much to pay for a note, or pool of notes?

2.) How long will it take?

3.) How much will I make?

Not to sound like an attorney, but the real answer to all of these questions is it depends. Realizing that it’s not the answer most folks want to hear, especially those thinking about jumping into the note business, or those contemplating the move into nonperforming notes, it really does depend on multiple factors. You also have to understand that there’s some trial and error involved, as well as a lot of common sense. But, that being said, I’ll try to break them down to explain a little further.

How Much to Pay?

Since the note business, in general, and not just bidding on notes, is a “learn by doing business,” it’s very hard in the beginning (I know I’ve been there), when you don’t have any data or a track record to go on. It’s also a business where you learn things by trial and error. The best advice here is to be sure to track your data and performance for future reference to assist you with future bids.

Due Diligence is a big factor as well. Of course you will look at generic criteria—depending on the asset class your bidding on (for example: commercial notes, first liens, or second liens)—such as fair market value, loan status, occupancy, etc. But as you improve your due diligence over time, your bidding will become more precise, and you will soon realize, like the more experienced note buyers, that your internal numbers are the most important factor to you or your organization.

Targeted Revenue is another difficult concept to determine when you’re new, since you have very little data to go on. My best advice is to make a dart throw until, over time, your own data becomes more accurate. Another way to start would be to track your data on an equity deal. I know for my company, we never used 100% as a figure for targeted revenue, regardless of equity, because every non-performing note has some degree of risk. And, you never know what could happen later, like increased expenses, falling market value, or that you might want to discount the payoff to exit the deal sooner.

How Long Will it Take?

This just leads me to another question which is, to do what? How long will it take to get the loan re-performing to hold in your portfolio? Or to just recapitalize, by selling the note, selling a partial of the note, or borrowing against the note (a.k.a. Collateral Assignment)? The length of time it takes to generate revenue will also depend on your asset class (for example: equity notes, REO’s, first liens, second liens, etc.).

Another important factor will be your experience level. When I was new, it took me longer to do everything, largely due to the fact that I was still learning. Efficiency of your collection process and note administration is another overlooked variable.

How Much Will I Make?

Previously, we touched on how due diligence, and your proficiency at it, can affect purchase price when getting ready to bid, but there are many other factors as well (for example, the quality of your workout process with the borrower). Efficiency of your model and the asset classes you’re buying come into play again. But, I think two other important factors enter the equation: Cost of Overhead and Cost of Capital.

Cost of Overhead is pretty obvious, when it comes to office and desk space. There’s a certain level of administrative expenses per note, but the biggest expense for us is usually legal. Both of these numbers have dropped dramatically over time as we become more efficient.

Cost of Capital is probably a bigger factor in my mind and really lends itself to, what type of business model do you have? Are you small buy-and-hold shop? Or, are you more of a velocity shop? How much capital and what type (OPM, IRA, institutional vs. private), also plays a big role in how much availability of product and what type deal flow you would need.

Oftentimes, folks, who are just starting out, ask me for my proprietary, corporate data, and even if I did tell them what it was, in most cases, it’s irrelevant to them and their model. If I’m a velocity shop with expensive capital, I’m forced to make decisions based on my costs and operating expenses, which aren’t as much of a factor for a smaller-scale buy-and-hold investor, who is working out of his house.

So, like I said earlier, when it comes to bidding on notes, it’s a “learn by doing business,” with lots of trial and error, but be sure to track your performance and due diligence data. And at some point, you may have to be like PPR was in 2007, and just take the plunge.

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About Author

Dave Van Horn is President at PPR The Note Co. – an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for over 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

10 Comments

Hi Dave,
I see that you have a company that trades notes. Could you please explain in a nutshell various note buying scenarios?

Here are the few examples:
An investor buys a performing note for 10K with a payoff of 15K and 175 months of $170/month in payments.
What will happen in each scenario:
1. the borrower stops paying after 3 months
2. investor decides to sell the note after a year – who will buy it?
3. your company goes out of business (I wish you well but things happen)

Same as above but the note is non-performing.

In general, what is the worst case risk? Can investor lose an entire principal? If not, what is a typical loss?

Thanks for reaching out!
I can’t speak to what other companies do, but, when we sell a performing note, we offer a performing note warranty. So, with your first scenario, if someone purchased a performing note and it stopped paying in 3 months, the buyer would, first, log a case on our website. The original asset manager, who worked the asset previously and has rapport with the borrower, would retouch the loan at no additional charge. It would be worked through our non-performing note process (phone campaign, mail campaign, door knock service, legal action). If the asset manager can’t get the note re-performing in a short period of time (4-6 months, depending on the demand letter period of that state), the notebuyer would be issued a note credit or refund in the amount of his/her initial principal. The asset manager, in this case, would get a charge back for not getting the note re-performing, so he/she certainly does have a vested interest in getting it fixed. The performing note warranty is active, with unlimited use, until the notebuyer has made back his/her initial principal in payments from the borrower, the notebuyer is refunded for his/her initial principal, or the notebuyer sells the note—it is not transferrable.
If someone buys a non-performing note, they can either work it themselves or place it with a servicer to get the note re-performing, if it still isn’t paying he/she may start down the legal path. There are many exit strategies, if the note owner wants to get out of the deal. I wrote an article on this topic, “Nine Exit Strategies When Dealing With Defaulted Notes.”
If he/she decides to sell the note after a year, there are many possibilities for who will buy it. There is a large market for both performing and non-performing notes. It may help to network with like-minded note investors via online platforms or live events. FCI also has a trade desk, as does other companies, which can be utilized for selling notes.
I certainly don’t see PPR going out of business, but in the off-chance that would ever occur, a notebuyer could take comfort in knowing that we use FCI as our servicer for performing notes. So, we pay for your servicing set-up fees, record your assignment, and transfer the loan. The only thing we don’t pay for is their servicing fee of what they collect each month. But, they are a licensed servicer, and they do all of the accounting for you. Using a servicer, such as FCI, is really the safest way to do it. Also, we have all of the paperwork or we do not sell the loan. So, you wouldn’t run into the problem of not having necessary documents in the event that we ever went out of business.
As far as risk level for a single note, this is a loaded question. It depends on what type of asset it is (1st, 2nd, commercial, etc.). It also depends on many other factors (FMV, sr. lien status, occupancy, homeowner intent, etc.).
I hope some of this helps! If you have any additional questions, feel free to ask.

You talk about a large market for notes. Is it available via traditional brokers (e.g. Fidelity, TDAmeritrade, etc.)? If not, how to get in? Is it possible to trade notes electronically the same as stocks and bonds, for example?

Am I correct, that if I buy a note through you or other similar company, it would look pretty much the same as opening a CD account at a bank – set it and forget it? No FDIC, but you guarantee the principal.

You mentioned some charges and fees. Are they wrapped into a note price or subtracted from monthly payments or something else? What are they as a percentage of note price?

If the principal of a performing note is guaranteed, is the whole thing somewhat similar to a corporate or municipal bond in terms of risk?

Would buying notes be similar to buying shares of mortgage REITs (e.g. REM, AGNC, NLY) in terms of risk/reward?

If I want to try it out, what is a minimum capital requirement for a performing note? Do I have to be an accredited investor (I am not)?

Well I would say no. Traditional brokers (e.g. Fidelity, TDAmeritrade, etc.) are not normally resources for notes. We started by buying from smaller servicing companies. Although now we do buy assets electronically, this is through MERS, transferred from large banks. It is possible that there are other ways to do so electronically, but since that’s not what we do, I can’t verify that.

Buying a note, regardless of what company you’re buying from, is more similar to having a rental property with a property manager than it is to opening a CD account at a bank. You have a cash-flowing mortgage with a servicer doing the collections and accounting for you. We warranty the initial investment principle minus payments received at the time of a re-default and buy back.

Yes, I think approximately $15 a month is the servicing fee through FCI (regardless of the monthly payment size, so it’s a flat fee). The return we advertize has already taken into account the servicing fee. FCI subtracts their servicing fee from the monthly payment that they collect.

Sure, it’s similar to corporate bonds, except a corporate bond isn’t secured to a piece of a real estate, which is often a primary residence that someone is living in/ raising their family in. Homeowner intent does go a long way in the note business.
Buying notes wouldn’t necessarily be similar to buying shares of Mortgage REITs, but our mortgage fund would be. The only difference is that Mortgage REITs are publically traded, and our note fund is a private offering.

Most of our performing notes are between 10k-30k on a 2nd, could be a higher on a 1st. You don’t have to be accredited to buy a note, but you do need to be accredited to participate in one of our note funds.

Thank you very much again for bearing with me but I have more questions if you don’t mind 🙂

When I compared note buying with opening a CD account, I was referring to the overall mechanics of the process (go to a website, fill in a form, send deposit, etc.). Since you compared it to a rental unit, here is the question:
– is note buying as time and effort consuming as buying a rental? My gut feeling is that it is not but I’d like to hear it from you.

Now, warranty or principal guarantee – to me they are the same but you may know the difference. Am I correct to assume that if I buy a note from your company for 10K with $100/month payments and 3 months later the borrower defaults, I would immediately get $9700 back (original principal less 3 month of payments)? So, effectively my only risk is not getting income I was supposed to get thus giving your company 3 month 0% loan, correct or not?

On your website there is a picture of a happy couple that bought a note for 20K that pays ~20%/year. How typical is this deal? Where do such notes come from? It is difficult for me to understand why someone would borrow at 20% interest and even more difficult why someone else would sell an asset that makes 20%.

On the note fund, am I correct to think that buying multiple notes has less risk than buying a single note? Is so, why note fund is restricted to accredited investors only? I’d rather have a small piece of 100 notes than a single note yet I am restricted from a less risky investment. Does not make sense to me.

Thanks for your questions.
No it’s much less time and effort consuming than buying a rental. I can relate to this because I used to own 40 properties. But, we own thousands of loans and it is definitely less work and less stressful.

It could take 4-6 months to get a credit or refund on a hiccup loan, since I mentioned that the asset manager would first try to get the loan re-performing. Since you purchased the asset from me, you would be the note owner. Any missed payments and late fees are added on to the payoff of the loan, so I couldn’t say that you’d never collect that. If we did get the note re-performing or you foreclosed you might be able to.

In reference to the website sample deal, right now, that’s not a typical deal because most are under 20% as equity comes back into the marketplace. But, it is possible. It would depend on a couple factors, such as how many payments are remaining, if there’s a balloon, if there’s equity, etc.

We buy the notes non-performing, we get them re-performing, and then we sell them. It’s the same reason you might buy a house wholesale, fix it up, and sell it retail. We’re more of a velocity shop, and we have to recapitalize to pay investors, overhead, employees, legal, and administrative fees, so we can’t buy and hold every loan.

Correct, our note fund is restricted to accredited investors due to the SEC’s requirements for the type of placement we have. But, there are advantages and disadvantages to this. You are right that one of the biggest risks in the note business is not having enough diversification in numbers. But, there is also risk in not having control of your investment—when you buy notes you do have control. That’s why these investments are different and why the SEC puts restrictions on companies that aren’t publicly traded. The note can, potentially, pay a higher yield because you’re buying it at a discount and could get a payoff prior to maturity. In fact, the odds of this happening are pretty high. It’s hard for me, personally, to determine which is better, so I actually do both.